Economics Group. Special Commentary. November 30, 2015

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1 Economics Group Special Commentary Anika R. Khan, Senior Economist (704) Nonresidential Construction Recap: November Discussion Recent economic activity and labor market conditions in the U.S. now show that downside risks to the outlook have largely faded. Real GDP growth increased at a 2.1 percent rate in the third quarter, and the inventory correction that detracted 0.6 percentage points from the headline is behind us. Financial markets are now gearing up for the Fed to increase its short-term target rate in December after being on hold for seven years. Although economic conditions appear steady in the U.S., the impact from the sharp drop in oil prices still lingers. Structure investment came in weak during the quarter as the mining exploration, shaft and wells component continues to hold back overall growth. In this report, we focus on the following themes in the nonresidential construction sector: Real GDP Contribution Structure investment was downwardly revised to a decline of 7.1 percent in the second estimate from a 4.0 percent decrease in the third quarter. The falloff in outlays was concentrated in the mining exploration, shaft and wells component, which detracted 11 percentage points from structure investment. With oil prices and rig count expected to settle at a much lower level than originally thought, the outlook for the drilling component remains tenuous. Sector View The nominal value of private nonresidential construction spending putin-place, which makes up 70 percent of structure investment, is expected to register a slower pace of growth in the coming year as outlays in sectors, such as manufacturing, hotel, office, and amusement and recreation moderate. Healthcare outlays will likely advance further in Construction Employment Labor market conditions in nonresidential construction continued to improve in October. One of the biggest worries in the sector, however, is the high level of unfilled construction jobs as workers displaced during the downturn found work in other sectors. Wage and salary growth in the construction sector remained unchanged during the quarter, but continues to outpace the nation. We expect as labor market conditions continue to firm, wage and salary growth should trek higher. Construction Costs The sharp drop in oil prices continues to keep prices in the construction sector at a low level. Prices for softwood lumber, gypsum and concrete, to name a few, remain low. However, in typical fashion, producers are already announcing price increases that will take place in the beginning of the year to see if gains will stick. Forward-looking Indicators Mixed Billings for architecture services in nonresidential components remained in positive territory in October, but institutional activity has been declining for several months. Nonresidential construction starts increased during the month, but the overall trend has been weak for the better part of the year. We suspect that billings and projects in the planning phase are providing a clearer signal for outlays in the coming year. That said, the trend in the Dodge Momentum Index remains supportive of continued gains. Construction Outlook Our forecast for private nonresidential construction put-inplace remains largely unchanged. We expect nonresidential outlays to increase 11.7 percent in 2015 and advance between 7 percent-9 percent in However, with institutional and manufacturing construction set to moderate in 2016, the overall pace will slow in the coming year. Structure investment came in weak during the quarter as the mining exploration, shaft and wells component continues to hold back overall growth. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 Much of the improvement is due to outsized gains in the manufacturing, hotel, office, and amusement and recreation sectors Construction Spending Outlook & Risks Private nonresidential construction spending is on track to finish the year up 11.7 percent relative to a year earlier. Much of the improvement is due to outsized gains in the manufacturing, hotel, office, and amusement and recreation sectors. Early indicators including billings and planning suggest these sectors will continue to see strong growth in the coming year, but the pace will likely moderate. Although the mining sector was hard hit due to the drop in oil prices, chemical manufacturers benefitted from the drop in natural gas prices and increased plant construction at a healthy clip. It is projected that more than 100 chemical plants have been built over the past three years. Much of the plant construction is taking place in Louisiana and Texas. For the lodging sector, third-quarter data continued to show solid improvement. Outlays in the lodging sector have outperformed in recent years, rising almost 21 percent in 2014, and more than 36.7 percent over the past year. According to Smith Travel Research, the occupancy rate remained elevated at 71.3 percent in the third quarter, the average daily rate (ADR) continued to advance and revenue per available room (RevPAR) was up 6.7 percent over the past year. Much of the increase in RevPAR is being driven by solid gains in ADR. Weekly activity in October and November continue to show a positive trend. The biggest risk we see in the hotel sector is the slower pace of global business travel and U.S. international visitation, especially in gateway markets. The pace of overseas visits has slowed, rising just 1.8 percent in April relative to a year earlier. In 2014, visitation was up 6.7 percent. During the third quarter, Houston and New Orleans were the only top 25 markets in the lodging sector to show a decline in RevPAR. Houston is also raising flags in the office sector. The pace of office-using employment in Houston fell to just 0.1 percent over the past year, while growth in the nation rose to 2.9 percent in October. At the same time, supply is far outpacing demand, which pushed the vacancy rate up in Houston to 15.7 percent in Q3. Unfortunately, the worst is likely not behind us. Deliveries are expected to spike in the coming years. Oklahoma City is another market that we are closely monitoring for weak performance in the office market. Net absorption in Oklahoma City fell in the third quarter, but supply has been subdued. We also find that officeusing employment in Oklahoma City is outpacing the nation. Following two years of declines, institutional building rebounded in Private healthcare construction spending is getting a significant boost from investment in hospital construction projects and is up 15.2 percent over the past year. Much of the increase, however, has been in renovations and expansions. Construction spending for medical buildings has been weak since mid-2014, and the improvement in special care construction spending is slowing. Theme park construction is booming and is up 52.1 percent year over year. Despite these gains, forwardlooking indicators suggest institutional outlays will improve at a slower pace in Figure 1 Figure Private Lodging Construction Year-over-Year Percent Change: 36.7% (Left Axis) Month-over-Month: -0. (Right Axis) Oklahoma City Office-Using vs. Total Employment Year-over-Year Percent Change Oklahoma City Office-Using : 3. Oklahoma City Total: Source: U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Securities, LLC 2

3 Nonresidential Construction Spending Outlook Forecast Real GDP, percent change Structure Investment, percent change Nonfarm Employment, percent change Construction Employment, percent change Nonresidential Employment, percent change Unemployment Rate Construction Unemployment Rate Nonresidential Total, Value Put-in-Place, $ billions Nonresidential Total, Value Put-in-Place, percent change Commercial, percent change Office, percent change Retail & Other Commercial, percent change Hotel, percent change Industrial Total, percent change Institutional Total, percent change Health, Value Put-in-Place, percent change Education, percent change Religious, percent change Public Safety, percent change Amusement & Recreation, percent change Power, Value Put-in-Place, percent change Transportation, Value Put-in-Place, percent change Communication, Value Put-in-Place, percent change Interest Rates - Annual Averages Ten-Year Treasury Note Forecast as of: Source: U.S. Department of Commerce, U.S. Department of Labor, U.S. Department of the Treasury and Wells Fargo Securities, LLC 3

4 Private Nonresidential Spending 6 Private Nonresidential Construction Spending 6 Private nonresidential outlays have been choppy as of late, falling to a $399.5 billion annual rate in September, down 0.7 percent from a month earlier. Moreover, lodging, commercial, manufacturing, and amusement and recreation, were weak during the month. However, the year-over-year trend is a bit more promising. Private nonresidential outlays continue to climb and are up almost 15 percent on a year-ago basis. This is largely on the back of strong gains in healthcare, chemical manufacturing, lodging and theme park construction. Although the value of construction put-in-place is volatile on a monthly basis, the trend in overall outlays is still supportive of gains Year-over-Year: 15.7% 3-Month Annual Rate: Private Manufacturing Construction 3-Month Moving Average Private Health Care Construction Year-over-Year Percent Change: 13. (Left Axis) Month-over-Month: 0. (Right Axis) Year-over-Year: (Left Axis) 3-Month Annual Rate: 1. (Right Axis) Private Amusement & Recreation Construction 3 Private Nonresidential Construction Year-over-Year Percent Change: 52. (Left Axis) Month-over-Month: -1. (Right Axis) Month-over-Month: Source: U.S. Department of Commerce and Wells Fargo Securities, LLC 4

5 Employment and Wages 9% Total vs. Construction Employment Year-over-Year Percent Change 9% Employment for nonresidential construction, which consists of building, heavy, and civil engineering and specialty, rose by 24,900 in October, following a more modest employment change the month prior. Much of the increase came from a surge in nonresidential specialty trade contractors (up 21,000), which rose 4.5 percent year over year. Overall, inflation in construction labor costs has been generally well contained. However, a shortage in specialty trade contractors should apply pressure to hourly wages in this sector. In addition, growth in average hourly earnings for construction increased in October, relative to the previous month, and sits at 1.9 percent year over year. Construction Wage & Salaries Year-over-Year Percent Change Construction: % Nonfarm Employment: Construction Employment: Construction Employment Year-over-Year Percent Change vs. 3-Month Annualized Rate % Month Annualized Rate: Year-over-Year Percent Change: Construction Unemployment vs. Avg. Hourly Earnings Rate, Year-over-Year Percent Change $ Average Hourly Earnings-Construction Private Sector Workers $ 3 2 Construction Unemployment Rate: 7. (Left Axis) Average Hourly Earnings YoY Percent Change: 1.9% (Right Axis) 1 $29 Average Hourly Earnings: $27.54 $29 $28 $28 2 $27 $27 $26 $26 1 $25 $24 $25 $24 1 $23 $22 $23 $ $21 $21 $ $20 Source: U.S. Department of Labor and Wells Fargo Securities, LLC 5

6 Leading Construction Indicators The value of nonresidential starts surged 32 percent in October to a $200.7 billion annual rate, following a weak September. The increase was broad based with commercial building starts jumping 49 percent and institutional climbing 23 percent during the month. Architecture billings remained largely unchanged in October, down less than one point to Commercial/industrial jumped 4.2 percent in October to a reading of.1, more than likely led by manufacturing billings, while institutional projects moderated on the month. The Dodge Momentum Index slipped 4.8 percent to in October, nearly erasing all of the previous month s gains. Weakness was broadbased with commercial building planning falling by 5.0 percent and institutional planning decreasing by 4.5 percent. Year over year, both are up 6.3 percent and 2.6 percent, respectively. Architecture Billings Index Seasonally Adjusted Architecture Billings Index: Institutional and C&I Architecture Billings Index, Seasonally Adjusted 200 Dodge Momentum Index Includes Nonres. Buildings Except Manuf., Year 2000= Institutional Billings: 51.4 Commercial/Industrial Billings: Dodge Momentum Index: Architectural Billings vs. Nonresidential Structures Index; Year-over-Year Percent Change, Seasonally Adjusted Architecture Billings: 52.5 (Left Axis) Nonres. Structural Invest.: -0. (Right Axis) Commerical & Institutional Building Planning Index Year-over-Year Percent Change Commercial Building Planning: 6. Institutional Building Planning: Source: The American Institute of Architects, Dodge Data & Analytics, U.S. Department of Commerce and Wells Fargo Securities, LLC 6

7 Construction Costs The PPI final demand for construction saw a modest increase from September s number and remains well ahead of total final demand. On a year-ago basis, construction costs are up 2.2 percent. Declines in oil and energy prices weighed on construction costs again during the month with metals such as steel and aluminum falling 16.1 percent and 26.6 percent year over year, respectively. However, some material prices such as concrete and gypsum remained somewhat elevated in October. PPI for materials and components for construction was rose a modest 0.1 percent in October. On a three-month annualized rate, however, this component fell for an eightconsecutive month and is down 0.4 percent on a year-ago basis. Producer Price Index 3-Month Moving Average, Year-over-Year Percent Change Asphalt Felts: -2. Gypsum Products: 0. Concrete Products: 2.7% % Construction Final Demand PPI Seasonally Adjusted Year-over-Year: 2. 3-Month Annualized Rate: PPI Final Demand Seasonally Adjusted 7% Year-over-Year: -1.7% 3-Month Annualized Rate: PPI: Materials & Components for Construction Quarter-over-Quarter Percent Change, NSA PPI: Materials & Components for Construction Seasonally Adjusted 9% 3-Month Annualized Rate: -1. Year-over-Year: -0. 9% Materials & Components for Construction: Source: U.S. Department of Labor and Wells Fargo Securities, LLC 7

8 Wells Fargo Securities, LLC Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) (212) John E. Silvia, Ph.D. Chief Economist (704) Mark Vitner Senior Economist (704) Jay H. Bryson, Ph.D. Global Economist (704) Sam Bullard Senior Economist (704) Nick Bennenbroek Currency Strategist (212) Eugenio J. Alemán, Ph.D. Senior Economist (704) Anika R. Khan Senior Economist (704) Azhar Iqbal Econometrician (704) Tim Quinlan Economist (704) Eric Viloria, CFA Currency Strategist (212) Sarah House Economist (704) Michael A. Brown Economist (704) Erik Nelson Economic Analyst (704) Alex Moehring Economic Analyst (704) Misa Batcheller Economic Analyst (704) 410- Michael Pugliese Economic Analyst (704) Donna LaFleur Executive Assistant (704) Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. ("WFBNA") is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2015 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE